The objective of a covered call writer is that the option expires Out Of The Money. Covered calls provide little downside protection, apart from the Premium received, hence they cannot be considered hedges against falling prices, but more a method to earn more income return from a stock than the dividends alone.
Covered calls are not without risk. If the price of the stock rises significantly, the covered call position is likely to get assigned and the investor will be required to sell their stock to the Option Buyer at the Strike Price (which may be a lot lower than the market price they could have received had they not sold Options on their stock).
Since most Stock Options are American Style (i.e. can be exercised at any time before expiry) covered calls are at far greater risk of being assigned if the stock will go ex-dividend during the lifetime of the option contract. Depending on the amount of the dividend, even if the sold Call Option is At The Money or slightly Out Of The Money, the option owner may decide to Exercise.
Covered call strategies are sometimes called Buy/Write strategies. In this case, the investor will buy the stock and sell a covered call in a single transaction.
Covered Calls are the synthetic equivalent of selling Cash Secured Naked Puts. Some investors consider this to be a preferable strategy since unlike a covered call, capital is not required to initiate them and it is possible to buy back the put if the underlying stock falls, without being exposed to the capital loss associated with owning it (although a loss will still be incurred to cover the naked short put).
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3 Required Skills for Covered Call Writing
Alan Ellman of The Blue Collar Investor describes three required covered call writing skills.
External LinksHow to Write Covered Calls: 5 Tips for Success
TradeKing article explaining the basics of covered calls.Covered Call Resources
List of resources for trading Covered Calls prepared by Gavin McMasterCovered Call (Buy/Write)
OIC article on covered call (aka buy/write strategies).Dividend capture with covered callsâ€”too hot, too cold, or just right!
Vamce Harwood describes an optimal strategy for covered calls that balances hedging the risk from the stock falling with the premium collected and when to time the entry to get some of the benefit of the dividend even if the covered call gets assigned.